Have you ever been on a diet? It doesn’t seem to matter which diet it is, they all go great to start. You start telling your friends about it and they get excited as they see the pounds melting off of you. Next thing you know, you have only 10 more pounds to lose…and then it all slows down.

So it goes with the Fed’s fight against inflation. We have seen inflation just melt away from the super highs of last year, but now that we are down to the 3 percent range, everything is slowing down. Unlike last month’s inflation surprise, the market this time has thus far shrugged it off.

The Consumer Price Index (CPI), which measures retail inflation, came in at 3.2 percent earlier this week, slightly higher than the 3.1 percent last month. The Produce Price Index (PPI), which measures wholesale prices, came in at 1.6 percent, up from 1 percent last month. Does this mean the battle is lost?

No, it does not. Many of our clients have heard me say this all along, but it is not a surprise that the last 1 percent or so of the drop back to the Fed’s target rate of 2 percent would be the most stubborn. This does not mean that the Fed needs to go back to raising interest rates; they simply need to be patient.

The current talk of the Fed is when to begin cutting. The pundits are obsessed with this, and they talk as if the market simply cannot keep rising without a rate cut. They have been wrong this whole cycle and they remain wrong. We do not need a rate cut. The economy is still chugging along; the Atlanta Fed’s GDPNow tracker has growth this quarter at 2.5 percent. Stocks prices, contrary to what many traders will tell you, track earnings growth, not interest rates. If earning are growing, stocks will rise.

I know what you are thinking, “But we are at all-time highs.” That is one way to describe it; another is that we are back to where we were three years ago. Meanwhile the economy and corporate earnings have grown. Besides, only the favored few that skew the S&P 500 index are back; all the other areas of the market are still making their way and have room to run.

The Fed may cut rates anyway, and if they do, the short-term traders will like it. They may decide to be more patient, and if they do, the short-term traders will not like it. Investors, however, make decisions from the bottom-up. We are looking at what is actually happening at the companies we own. For the vast majority Fed policy is low on their priority list.

Starting in the last three months of 2023, the market has finally been acting the way it should. Nothing goes in straight lines and there will be down days. We will eventually see a correction in 2024 – we hardly ever go a year without one – but the overall direction should remain up, and it should be driven by all those areas of the market that are not deemed “Magnificent” by the pundits who just keep getting it wrong.

Warm regards,

Chuck Osborne, CFA
Managing Director

~Those Last Ten Pounds

We live in a world of clickbait: Everything must be a crisis, and all is exaggerated. It gets very tiresome. On Tuesday the market dropped dramatically because of the “HOT” inflation report. The Consumer Price Index came out indicating that inflation is running at an annual rate of 3.1 percent. So-called core inflation, which is prices not including energy or food, rose 3.9 percent. So, is that hot?

The story is that this is a bad report because it was higher than expected; the expectation was for inflation to be 2.9 percent and for core inflation to be 3.7 percent. So, relative to expectations we were a whopping 0.2 percent higher. However, based on the previous readings, inflation went from 3.4 percent to 3.1 percent. It was 3.7 percent as recently as September. Core inflation remained the same.

Inflation is not actually heating back up, it is cooling; it simply did not cool as quickly as predicted. In the real world, things do not move in straight lines. Have you ever had to click that box online that says, “I am not a robot?” That test seems silly…couldn’t a robot simply click the box? It turns out that clicking the box is not the test. The test is the path one’s curser travels to get to the box, since only a robot can use a mouse to move the curser in a perfectly straight line. Inflation (as all economic data) reflects human activity: We don’t move in straight lines, thus neither does the data that reflects our activity. We humans do, however, move in a general direction; there is a trend, and the trend for inflation remains down.

The market pundits remain fixated on the Fed and interest rates, and they worry that a slower drop in inflation means rates stay where they are for longer. In our opinion, this worry is misplaced. Stock prices are determined by earnings. It is not that interest rates do not matter, they do – companies have to borrow money, and the interest that they pay will reduce earnings. Additionally, investors who calculate the future value of a company do so with what we refer to as a discount rate. The easiest way for non-mathematical people to understand this is that the potential return on stocks must be compared to what one could earn collecting interest from a very safe bond. If the rates on the bond are higher, then investors will theoretically be less willing to buy stocks, which drives prices down.

Do these worries make sense? The first concern does not. As long as the economy keeps growing, then companies will continue to grow earnings. The initial reading for the fourth quarter GDP came in up 3.3 percent. The real-time reading from the Atlanta Fed’s GDPNow is 3.4 percent. Current interest rates are not stopping growth, so the idea that they must be cut for growth to occur is simply wrong.

The discount rate issue is also greatly exaggerated. Most investors are using the 10-year Treasury for their discount rate. We do so because investing (as opposed to trading) is a long-term endeavor. The 10-year is in a range around 4 percent; this was normal before the Fed took extraordinary measures in response to the 2008 financial crisis, which was then deemed the “new normal.” After Covid they said it was a new-new normal. Today we are in the normal-normal, and that is not restrictive for stocks.

Lastly, I feel confident saying the market pundits are wrong, because the market itself keeps telling them they are wrong. I am not sure how long they can all stay wrong and still be employed, but I assume that they believe there is safety in numbers.

We are all human beings. We get it wrong sometimes at Iron Capital too, but we climbed out on a limb in 2023 when seemingly all the pundits were calling for a recession: we were right, they were wrong. Thus far in 2024, that is another trend that continues. We are not doing anything magical over here, we are simply ignoring the headlines and paying attention to reality.

Warm regards,

Chuck Osborne, CFA
Managing Director

~Headlines vs. Reality

Goodbye 2023 and hello 2024. To say that 2023 has been challenging would be a gross understatement, so I am not sad to see it go. A new year always brings hope for new beginnings.

We have written all year about the frustration of false narratives and a misleading S&P 500, which has become dominated by just seven stocks. However, we must admit that it has ended on a much brighter note. Patience has paid off, and finally the onslaught of solid economic data paired with the slowing of inflation has made the bears change their tune. Of course, admitting that you are wrong is a very hard thing, so most pundits have moved from “a recession is certain” to, “we are headed for a soft landing.” What does “soft landing” mean? It means one can admit we are not headed into a recession while not admitting that he has been completely wrong for 18 months.

Not only have we rallied, but it has been a broad-based rally to the end, unlike earlier in the year. We have been saying for some time that small company stocks look more attractive than the large technology stocks that have dominated in 2023, yet the market continued to ignore them, until they didn’t. Through December 19, the one-month return for the Small Value index is 12.72 percent, and for the Small Growth index it is 12.46 percent. The Large Growth index, which has dominated, returned 5.63 percent over the same period. Small Value, which we have been very keen on, is now up 14.45 percent YTD. Should it finish there, many will look back at 2023 and say, “Chuck, why the frustration? Yes, that is a lesser return than the S&P 500, but it is still pretty good. Don’t be such a sourpuss.”

True enough, but this is what lay people often miss: the year-to-date return is now 14.45 percent, but 12.72 percent of that happened in just the last four weeks. This is how stocks actually move. They do not go up steadily at a 14.45 percent rate for 12 months; they go nowhere for long periods, and then they jump. This is both why it is impossible to time the market and why it is so tempting to try to time it anyway.

We often say that it is actually fairly easy to know what the market is going to do, it is just impossible to know when it will do it. Small company stocks were too attractively valued to not eventually get some love, but they stayed that way for a frustratingly long time. This is why investing requires patience. It is good to end the year with that patience paying off.

So, is this it? What will 2024 bring us? Many are saying that the market has come too far too fast and is too expensive. They are right if the market is defined as seven large stocks in the S&P 500. Interestingly, the S&P, led by those seven stocks, is slightly above where it was at the beginning of 2022, the year of the bear market. However, a well-diversified global stock portfolio that includes the S&P but also small companies, international companies, and value stocks, is still roughly 8 percent away from getting back.

We are optimistic heading into 2024. We do believe the rotation away from large technology stocks and into everything else will continue. That may dampen the return of the S&P 500, but we don’t have to invest only in the S&P 500. We would not be surprised to see a January correction as investors take profits in what worked in 2023, but those proceeds are likely to go into the other areas of the market. That would be healthy.

In the end, 2024 will be what it will be, and we will have to face the reality of what is even if that isn’t what we think it should be. Prudent investing takes patience. After all, we are in it for the long haul.

Happy New Year!

Warm regards,

Chuck Osborne, CFA
Managing Director

~Out with the Old, In with the New

Is it true? If there was one thing that was absolutely forbidden in my house growing up, it was telling a lie. Whatever we had done wrong that led to the interrogation would pale in comparison to being caught in a lie. Punishments would increase tenfold if we attempted to lie our way out of trouble.

As a child I didn’t always appreciate what my parents were doing, but I realize now that they were providing me a foundation built on the hard rock of truth. If I have a gift as an investor, it is the trait to always question the narrative and favor reality. This trait, which my parents instilled in me at an early age, has served me well during my more than 30 years in the investment industry.

It is also why I have found 2023 to be so frustratingly maddening. This year the market has been dominated by narrative and has largely ignored reality. However, as the facts keep piling on, the cracks in the narrative continue to widen. Eventually, truth will out. The narrative here is that we are heading for a recession because interest rates have risen. Every quarter this year Wall Street economists have predicted anywhere from zero to negative economic growth, and every time they have been embarrassingly wrong. The initial reading for last quarter was GDP growth of 4.9 percent.

Instead of celebrating and rejecting the narrative, the pundits said this must mean that inflation is still high so the Fed will do more, which will cause an even bigger recession…except that consumer prices were flat month-over-month in October, and producer prices actually fell. This means the year-over-year numbers were also lower than expected.

The market finally seems to be catching on. We have seen a strong rally that has also been broad-based. Small company stocks are up strongly over the last week, which bodes well. We knew this would happen eventually, because our view had the strong foundation of being built on actual data. The truth matters.

It is Thanksgiving once more, and we have much for which to be thankful. I am primarily thankful this year for the strong foundation that my parents gave me. We lost my 92-year-old mother on October 23, and my 94-year-old father followed her this week. One of the nurses who cared for them said she couldn’t believe the downturn in my father over the past month, and we explained that he was a 94-year-old man with a broken heart. In life, like in investing, we must take the good with the bad. There is no return without risk, there is no joy without suffering, and there is no gratitude without loss.

I will be sad this Thanksgiving, but that doesn’t mean that I am not extremely thankful. In keeping with our tradition, here is my list:

~ I am thankful that we base our investment decisions on facts and not narratives.

~ I am thankful for the strong foundation that my parents provided for my four siblings and me.

~ I am thankful that college basketball has begun, and that Duke has already lost a game.

~ I am thankful for our two children, who are keeping my wife and me very busy.

~ I am thankful that our son is getting his driver’s license and will be running errands for the family very soon.

~ I am thankful for my family, immediate and extended.

~ I am thankful for all of my friends.

~ Of course, I’m always thankful for Mama’s pumpkin cheesecake, though she hasn’t made it herself in several years, and this will be the first she isn’t here to enjoy it. I don’t think she will mind me eating her slice.

~ I am thankful for my Iron Capital team, whose loyalty, diligence, and excellence have helped Iron Capital reach the milestone of 20 years in service to our clients.

~ Finally, I am thankful for you, our clients and friends. Your trust in Iron Capital is our greatest asset and we value it every day of the year.

Happy Thanksgiving!

Chuck Osborne, CFA
Managing Director

~Foundation

What was the most important moment in Jerome Powell’s post-Fed meeting comments this week? I believe it was when a reporter asked about the Fed staff removing recession from their forecast. Powell responded, “It is hard to see a recession when one looks at the data.”

Last quarter began with the so-called blue-chip consensus of economists predicting 0 percent growth; actual growth was 4.9 percent. That announcement didn’t seem to matter, and the narrative on Wall Street remained that we must go into recession because of interest rate hikes. Earnings have been much better than expected with 78 percent of companies outperforming expectations. That didn’t faze the narrative, however, and only 38 percent of companies have seen their stocks rise on earnings. The broken records that have been wrong for this whole cycle kept insisting that gloom and doom are right around the corner.

Then Jerome Powell said, “It is hard to see a recession when one looks at the data.” Maybe, just maybe, reality will trump narrative just this once. If so, the market should rally for a while. I know most people either do not pay attention at all or if they do, it is just to the S&P500, which most in the media refer to as the stock market. That index, which is heavily skewed by a handful of extremely large technology companies, is down approximately 8 percent from the beginning of 2022. However, global markets as a whole are still down almost 20 percent. We have become accustomed to the market dropping rapidly and then bouncing back rapidly, but this bear market dropped, then had several false starts on rallies, but has stayed down.

What is frustrating about this is that company earnings and the economy as a whole have not stayed down. Stocks are supposed to forecast roughly six months in advance, yet stocks bottomed after the two quarters in a row of negative GDP growth in 2022, which was mysteriously not declared a recession. Since then, the real world has been slowly recovering. Company earnings as a whole have re-entered growth – slow growth, but growth. The GDP growth numbers have been between 2 and 5 percent every quarter since, yet the market continues to stay depressed.

While most pundits focus only on the S&P500 whose value is skewed by a few very large companies, most stocks are priced for a recession while we are actually growing at 4.9 percent. Banks are priced as if we are in a crisis, and we are not. Energy companies are priced as if oil were at $40, and it is above $80. Utilities have acted as if no one in America is paying their bills even while we have less than 4 percent unemployment. I could go on and on.

Perhaps this is finally the time where the market wakes up and realizes that it has gone too far to the downside and stayed down too long. We had the recession already; we are not going into a new one. We will keep our fingers crossed. If the rally fails once more, then we just have to stay patient. I’m sure that some pundits who have seemingly risked their careers on the persistently wrong calls for a recession will stay at it. However, some may have actually listened. Recession is hard to see for anyone who is actually looking at the data.

Warm regards,

Chuck Osborne, CFA
Managing Director

~Listen Carefully